Tuesday, June 28, 2005

digging into Sears Holding (SHLD)

(Disclosure: I am short SHLD)

Of all the research that I'm able to access, I think the highest quality comes from Bear Stearns. That's why I was particularly interested in their recent initiation of SHLD at outperform (TP $169). Though I disagree with their conclusions, they've done an excellent job at bringing up key issues and data points that longs and shorts need to consider. I'll refer to several of these issues in this post and will also touch on some of the points made by Morgan Stanley (initiated at underperform).

BS brings up the issue of "Expanding Distribution Points of Key Hardlines Brands." The idea here is that Sears brands like Kenmore, Die Hard and Craftsman will be sold in K-Mart stores and Sears Essentials/Grand stores (off-mall formats). Sears has been getting hit hard in hardlines in recent years particularly from HD and LOW. Maybe if these key brands are off-mall, SHLD can recapture some share. The main problem with this is cannabilization. Suppose I am in the market for some Craftsman tools. Also suppose that a brand new Sears Essentials store opened a mile from my house and a Sears mall-based location is 3 miles from my house. Hooray! I can cut down on my drive and pick up my tool set at Sears Essentials (and not Sears mall). But I'm not going to buy an additional tool set from Sears at the mall anytime soon. I think this cannabilization effect could be very harmful to SHLD.

BS mentions that Sears and KMart systems are lousy. Inventory management, merchandise planning, logistics, supply chain systems all need to be improved. These systems at Sears and KMart are nowhere near as sophisticated as TGT or WMT. It seems that SHLD will more or less live with these problems (and continue to lose ground to comp.) and go on with 2 sep. groups of systems as opposed to the massive, costly, complicated systems upgrade and integration project.

One issue that I found very interesting is the fact that pricing on consummables (e.g. detergent, paper towels, cereal) at KMart is up to 20% more expensive (on the same item) vs. WMT or TGT. This is significant in that consummables will be ~15% of Sears Essentials merch. Will an increasingly savvy consumer stand for this or will she pick up some tp with her treadmill? SHLD is really trying to pick up some GM here, but if they hold the line on pricing, they will put their store traffic numbers at risk.

MS feels that SHLD could sell maybe 30 S mall stores each year at an avg. price around $55/sq ft. BS also feels that SHLD divestitures of S mall stores would take time (200-300 at once would flood the market with supply and crush pricing) but they lean more towards $100/sq. ft. Regardless of which number you wish to use, the question is "Who will buy these S mall stores?" BS thinks WMT, TGT and COST are candidates (esp. TGT) but these are all primarily off-mall retailers. BBY, BBBY, HD, LOW and LIN are seen as maybes but I see the probability here as low.

Some stats from BS on real-estate overlap (pot. for closures, re-formats)
KMART has 50% of stores within 5 mi of S and 87% within 10 mi
S has 57% of stores within 5 mi of Kmart and 83% within 10 mi

Both MS and BS see the $500 million cost synergy number as conservative ($1B is a possiblity)

BS paid a visit to a re-designed KMart store (pre-merger) and came away extremely impressed (better lighting, organization, signage) but these redesigns cost money -- money that Chairman Eddie does not want to spend. The op. margin expansion story does make sense to me (fire a bunch of people and cut back advertising expense) but I don't think the sales impact to issues like poorly org. stores, little adv., loss of people talent, outdated systems, reduced capex get enough attention. BS is looking for between 0.3% and 0.8% total sales growth in the next 3 yrs. at SHLD. I really don't know how that can happen.


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